2023 Tax Calendar
VIEWpoint Issue 2 | 2022
Inflation Reduction Act: Highlights of Key Changes for You and Yo...
The 2022 Gift Tax Return Deadline Is Coming Up Soon
HUD Strengthens the Effects Test
President Biden’s Proposed Budget Includes Notable Tax Provis...
Transferring a family business to the next generation requires a delicate balancing act. Estate and succession planning strategies aren’t always compatible, and the older and younger generations often have conflicting interests. By starting early and planning carefully, however, it’s possible to resolve these conflicts and strategically transfer the business in a manner that is aligned with the goals for all family members, whether involved or uninvolved in the business, and in a tax-efficient manner.
One reason transferring a family business is such a challenge is the distinction between ownership and management succession. When a business is sold to a third party, these two processes typically occur simultaneously. However, in the family business context, there may be reasons to separate the two.
From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing estate taxes. The recently passed Tax Cuts and Jobs Acts also provides an additional estate tax savings, as the exemption level has doubled from $5 million to $10 million.
On the other hand, some business owners may not be ready to hand over the reins of their business or feel the next generation isn’t quite prepared to take over. There are several strategies owners can use to transfer ownership without immediately giving up control, including:
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. It’s not unusual for a family business owner to have substantially all of his or her wealth tied up in the business. Providing heirs outside the business with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth while allowing those who work in the business to take over management. However, giving too much ownership to children not involved in the company can potentially destroy the business and family dynamic.
Despite statistics to the contrary, the involved heirs working toward growing the business could potentially develop the idea that they are also building value for the uninvolved heirs, which could lead to frustration on their part and result in them acting in their best interest, not the company’s, or even starting a separate business. This is part of the reason why second-generation businesses don’t always flourish – the owner failed to establish a strategic plan that accommodates all heirs.
While the current generation thinks they are being fair to all their children, it also is not ideal for the uninvolved heirs either, as they are essentially holding ownership in a closely held business where management is not focused on maximizing company value. In my experience, giving ownership of more than 10 percent to each uninvolved heir and/or 25 percent of the total ownership seems to be the tipping point creating a negative dynamic. The most optimal planning focuses on giving ownership based on earning it versus birthright, but balancing the desire to be fair to all heirs.
Most M&A advisors, like those at Doeren Mayhew Capital Advisors, usually recommend first transferring ownership in other assets, such as business-occupied real estate or assets outside of the company. While this approach is the most optimal, it may create some conflict.
For example, a client gifted ownership in the business-occupied real estate to the uninvolved heirs and the majority of the business to the involved family members. However, the real estate rapidly appreciated after estate planning, making the original gift now disproportionate and leaving the business in a position where it needed to relocate, but the respective owners of the business and real estate had conflicting goals.
Another strategy is to purchase life insurance to create liquidity for family members not involved in the business.
A few keys to optimal planning include:
Another unique challenge presented by family businesses is that the older and younger generations may have conflicting financial needs. For example, a business owner may be relying on the value of the business to fund his or her retirement, while his or her children might hope to acquire the business without a significant investment on their part.
Fortunately, several strategies are available to generate cash flow for the owner while minimizing the burden on the next generation.
Because each family business is different, it’s important to work with an advisor to identify appropriate strategies in light of your objectives and resources. To obtain assistance, contact our leading middle-market M&A advisors today.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
A quick registration is required to view our resources.
You will only be asked to do this one time (unless you don't save your browser cookies).